Edited version of private advice

Authorisation Number: 1052114856163

Date of advice: 5 May 2023

Ruling

Subject: Cryptocurrency trading scam

Question 1

Is the Trustee for the X Trust (the Trustee) entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the losses incurred in a cryptocurrency trading scam?

Answer

No.

Question 2

If the answer to question 1 is 'no', did the Trustee make a capital loss on the amounts that were invested and lost in the cryptocurrency trading scam?

Answer

Yes.

This ruling applies for the following period:

xx 20XX to xx 20XX

The scheme commenced on:

xx 20XX

Relevant facts and circumstances

The Trust sold its primary business during the year and decided to become a cryptocurrency trader.

The Trustee was introduced to a trader-led platform (The Platform) that allowed more regular trading which fitted into their business model.

A cryptocurrency exchange was mostly used as the exchange.

The Trustee states that all transactions were based on the website, which was essentially like an online banking/broker platform. All trades could be viewed, and the balance and earnings were easy to see and track.

The process for engaging with The Platform involved the Trustee taking money out of various Australian bank accounts and transferring it to exchanges to purchase cryptocurrency. The Trustee then transferred the cryptocurrency to The Platform which was then purportedly used for cryptocurrency arbitrage trading.

In addition to the funds that the Trustee used to purchase cryptocurrency that was transferred to The Platform for arbitrage trading, further funds were transferred to exchanges to purchase cryptocurrency. This cryptocurrency and other cryptocurrency held in a Cold Wallet was also transferred to The Platform, to pay the purported commission amounts on the scheme.

The Trustee has provided information on why the The Platform were operating as a scam.

The Trustee reported the matter to the authorities and understand there to be an active investigation into the matter.

The Trustee engaged an independent specialist crypto recovery organisation, however:

•         attempts to recover the amounts the Trustee invested have stalled

•         the advice the Trustee has received is that the funds have been moved into numerous other locations and are not able to be associated with the owner of the account

•         a 'tracing report' from the recovery organisation was provided by the Trustee in support of the Ruling Application

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-60

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless stated otherwise.

Question 1

Summary

The Trustee is not entitled to a deduction under section 8-1 for the losses incurred in a cryptocurrency trading scam.

Detailed reasoning

Section 8-1 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income except to the extent they are losses or outgoings of capital or of a capital, private or domestic nature.

Case law has found that the loss, if due to misappropriation, is not deductible under section 8-1 but is capital in nature

In AAT Case 4069 (1988) 19 ATR 3117; 88 ATC 244 the taxpayer company, at the suggestion of its solicitor, entrusted moneys to that solicitor as its agent for the purposes of acquiring gold bullion and its immediate pre-arranged re-sale at a profit. However, the solicitor misappropriated the money in advance of the proposed scheme. The company claimed as a deduction the loss incurred as a result of its dealings with the solicitor.

Mr P M Roach, Senior Member, determined that a deduction was not allowed because the taxpayer proposed to embark on a course of action intended to produce a profit and the sum of money to be invested in that project was capital as it was to provide the profit-making structure. The act of misappropriation by the solicitor occasioned the loss, not any dealing in bullion.

The view that a loss due to possible misappropriation is not deductible but is capital in nature is supported by Income Tax Ruling IT 2228 Income tax: futures transactions. In IT 2228 the Commissioner discusses the income tax implications of the various aspects of futures trading. While your case does not involve a broker or dealer of futures, the same principles apply. Paragraph 36 in IT 2228 deals with losses sustained as a result of fraudulent action of futures brokers or dealers:

36. Furthermore, it seems that there may be a number of cases where taxpayers engaged in futures transactions may have incurred losses not from futures contracts themselves but from futures brokers or dealers acting in a fraudulent manner. In managed accounts, for instance, a taxpayer may have deposited $20,000 with a broker to enter into futures contracts on the taxpayer's behalf. The taxpayer may be advised by the broker at a relevant time that losses amounting to $10,000 have been suffered. In fact, the losses will not have been incurred from genuine futures transactions. They may be incurred from fictitious transactions and, in some case, from misappropriation of the taxpayer's funds. It is difficult to say the losses incurred in these circumstances are losses incurred in carrying on a business or in carrying out a profit-making undertaking or scheme. They have more the character of losses of capital. Claims for deductions for losses incurred in these circumstances should be disallowed.

In this case, it was the Trustee's intention to engage in trading on The Platform and to create a passive income stream. However, the facts indicate that The Platform was acting in a fraudulent manner and the cryptocurrency the Trustee acquired and transferred to them was misappropriated. In this case, the losses were not incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. As the loss is capital in nature, the Trustee is not entitled to a deduction under section 8-1.

Question 2

Summary

The Trustee made a capital loss on the disposal of cryptocurrency that they transferred to The Platform and lost in the cryptocurrency trading scam.

Detailed reasoning

Section 102-20 states that a capital gain or capital loss is made only if a capital gains tax (CGT) event happens.

Section 108-5 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Taxation Determination TD 2014/26 Income tax: is bitcoin a "CGT asset" for the purposes of subsection 108-5(1) of the Income Tax Assessment Act 1997? explains that Bitcoin, and by extension, cryptocurrency in general, is a CGT asset.

The disposal of cryptocurrency that is not part of a business or commercial transaction will give rise to CGT event A1 under 104-10(1). A capital gain or loss is worked out at the time of the disposal.

Section 104-10(2) provides that you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

The capital gain or loss is the difference between the cost base (which includes the acquisition cost of the CGT asset) and the capital proceeds from the CGT disposal event.

The capital proceeds from a CGT event under the general rules in subsection 116-20(1) are the total of the money you have received, or are entitled to receive, in respect of the event happening, and the market value of any other property you have received or are entitled to receive.

In this case, the Trustee transferred money from Australian bank accounts to cryptocurrency exchanges. These exchanges allowed the Trustee to purchase cryptocurrency.

CGT event A1 occurred when the Trustee transferred cryptocurrency from the exchanges and Cold Wallet to The Platform. That is, when the Trustee ceased to be the cryptocurrency's legal or beneficial owner due to The Platform scam.

Further, subsection 116-60(1) provides that the capital proceeds from a CGT event are reduced if your employee or agent misappropriates (whether by theft, embezzlement, larceny or otherwise) all or part of those proceeds. The capital proceeds are reduced by the amount misappropriated. An agent can be described as someone who acts on behalf of another.

Based on the information provided, it is accepted that the investment turned out to be a 'scam' as The Platform eventually ceased all communication and the company website was taken down. Therefore, the cryptocurrency the Trustee transferred to the platform was lost.

Further, it is appropriate to consider that the person(s) running The Platform to have been the Trustee's agent in 'managing' their 'investment'.

Consequently, under subsection 116-60(2) the capital proceeds the Trustee was entitled to receive from the CGT disposal event are reduced by the amount misappropriated.

Therefore, the Trustee is entitled to claim a capital loss for the disposal of the cryptocurrency transferred from their cryptocurrency exchanges and Cold Wallet to The Platform.

Under subsection 116-60(3), if the Trustee later receives an amount as a recoupment of all or part of the amount misappropriated, the capital proceeds the Trustee was entitled to receive from their disposal of the cryptocurrency are increased by the amount received.

A capital loss cannot be offset against income from other sources, it must be offset against any current year capital gains and may be carried forward to offset against future capital gains.

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